A stress test shocker

By Felix Salmon
May 6, 2009

So much for anchoring. You thought BofA might need $10 billion in new capital? Try $35 billion. Or, in English, lots and lots and lots of money — much more money than the bank could conceivably raise privately.

The first obvious question is “if BofA needs $35 billion, how much does Citi need?”. Which leads straight into the question of how much the other 19 banks need, in aggregate — it’s likely to be a shockingly enormous sum.

The second obvious question is “when will Ken Lewis and Vikram Pandit resign?” — I can’t imagine either of them surviving a forced capital injection of this magnitude.

And the third obvious question is “what on earth does Treasury think it’s doing”, leaking the stress tests in such a ham-fisted way, with each iteration worse than the last.

I don’t blame the banks for being angry. They have hundreds of people making sure that they’re well capitalized; Treasury then sends in a handful of wonks to look over the books and a few weeks later determines that they’re off by $35 billion? That’s quite a shortfall, especially when there’s really no indication that Treasury is better at working these things out than the bankers are.

I fear that in the wake of these stress tests, Treasury will have created an atmosphere of antagonism and mistrust which is going to make it almost impossible to push through the kind of root-and-branch regulatory reform that’s desperately needed. Without the banks’ buy-in, no new regulatory structure is going to work — but right now the banks have every incentive to hide things from Treasury and the regulators, rather than to work with them to strengthen the system as a whole. The stress tests might end up improving the banks’ TCE ratios — but that doesn’t mean they will end up improving the health of the financial system as a whole.

Update: There’s been a bit of confusion about what I was trying to say here, so let me clarify: Treasury might well be — and probably is — entirely correct about the amount of capital the banks need. But from the banks’ point of view, that’s not true: they think that Treasury is being too harsh. Which will make them unwilling to cooperate and will create an antagonistic playing field.

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